Top Ten Bad Assumptions: 9 – People making more cause other people to make less.

Alternate Assumption: People making more cause other people to also make more.

Income inequality is one of the hottest political issues in America today.  People don’t think it is fair that some people make substantially more money than other people.  Proposed solutions include increasing taxes on the wealthy, raising the minimum wage, and limiting the pay of CEO’s.  The key assumption in this whole debate is that the total amount of wealth is a fixed pie.  People who take a bigger slice of pie force others to take a smaller slice.

It is a basic principle of economics that wealth is not a fixed pie.  It grows and contracts. The key to growing wealth is voluntary transactions.  For example, you buy a cup of coffee.  You are buying the coffee because to you the coffee is worth more than the money that you are paying for it.  The coffee shop owner sells you the coffee because to him or her, the money you pay is worth more than the coffee.  You both feel you are better off by making this transaction.  If not, you wouldn’t make the transaction.  This transaction has made both you and the coffee shop owner better off than if you hadn’t made the transaction.  In essence, you are both a little bit wealthier.

The key here is that the transaction is voluntary.  If the transaction is not voluntary, wealth is not increased.  If someone steals your money, wealth is not created.  When government taxes you, wealth is not created.  It is only when the transaction is voluntary, when both parties to the transaction think they are better off, that we create wealth.

Steve Jobs was exceptionally good at creating wealth.  When he returned to Apple as CEO, Apple was on the verge of bankruptcy.  Now Apple has the highest market value of any company in America according to the latest rankings by Fortune magazine.  Steve Jobs earned billions as a result.  He was not the only one who benefited, however.  Millions more benefited from his success.  pPeople who invested in Apple, work for Apple, work for companies who sell to Apple, work for companies who develop software for Apple, or who simply enjoy using iPhones and iPads are all better off.   Would all of these people have better lives if we stopped Steve Jobs from creating wealth because he made too much money?

In the feudal societies of the middle ages, most transactions were not voluntary.  Nobles forced serfs to work for them and taxed from them just about everything they had.  Kingdoms grew wealthy not from innovating and creating but from plundering weaker kingdoms.  In these feudal societies, the assumption that one person growing wealthier causes others to become poorer was valid.  It is also why society did not progress for over a thousand years.  This assumption is also true in a modern autocratic society where dictators plunder from the rest of the population.

It is not true, however, in societies where most transactions are voluntary, where there is economic freedom.  The Heritage foundation ranks each country by economic freedom. Look at their rankings:  2015 Index of Economic Freedom.  Note that the most economically free countries are also the wealthiest countries.  The least free countries are the poorest countries.

Bernie Sanders, the Vermont senator who is currently running for president, is calling for a top tax rate of 90%?  Why should an investor put money into a risky new company that might become the next Apple if when the company fails, the investor loses everything, but if the company succeeds, the investor only gets to keep 10% of the gain.  The investor doesn’t make this investment and just puts the money in the bank for a safe low interest. As a result, society loses the next Apple.

The belief that people making more cause other people to make less is a very popular, very dangerous, very bad assumption.

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